Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

NEW-DRUG DEVELOPMENT

Development of a new drug is a risky business. Of the virtually infinite number of molecular compounds that may have pharmacological effects, drug companies must choose carefully the compounds in which to invest the millions of development dollars required before launching a new product on the market. The development process is composed of several stages, during which the drug company gathers evidence to convince government regulators that it can consistently manufacture a safe and efficacious form of the compound for the medical condition it is intended to treat. At the end of each stage, the company uses the technological and market information revealed up to that point to decide whether to abandon or continue development of the compound.

Drugs that reach the market in the United States typically pass through the following stages.

• Discovery. In this stage, chemists and biologists expend a significant amount of effort to develop concepts for synthesizing new molecular entities (NMEs). Many such entities are abandoned at this stage.
• Preclinical. The NME is screened for pharmacological activity and toxicity in an artificial environment and then in animals. If the NME is a promising candidate for further development, the company files an Investigational New Drug application with the U.S. Food and Drug Administration (FDA). An approved Investigational New Drug application allows the company to continue development by testing the drug on humans in clinical trials. ...